Roth conversion study surprised result

[googily]

I had zero Roth three years ago, so even though I'm still working, I have converted about $230k (edited). Have mentioned many times elsewhere about being widowed, RMDs+pensions+SS looking like it would be a big tax hit, unlikely to really be in a low bracket at any point in retirement, etc.

I have taken a different mental approach, though. If my employer came to me and said, "we want to give you a raise and you can put every penny of it in Roth, but you have to pay taxes on it," would I turn them down? I'm already in the 24% bracket, so my "raise" doesn't push me into a higher bracket.

As someone said upthread, some of this is so that I can have a tax free pot of money at the ready if I am wanting to make a big withdrawal from my IRA but don't want to get pushed into 32%.

Plus, given the run up of the past few years, that's a nice pile of proceeds that I'm not paying any tax on, compared to if my "raise" just went into my taxable account.

Mental gymnastics, I know, but I don't regret making a push even while still working to go from 0% Roth monies to 11%.

 

[sengsational]

One would hope the software has been modified such that the 400% cliff is eliminated for 2021 and 2022. There's a phase-out starting at 400% but not a cliff - in 2021 and 2022, according to current law....

My Roth strategy has been very easy to optimize: convert to just shy of the cliff. Sounds like Pralana's rules agree. Now it's getting a little more challenging, but I figure I'll do what I always do...buy the tax software in November and do a sensitivity analysis. Maybe dial it up to 22% and call it a day. The sharpest point I've had on this calculation was running i-orp, and I learned that the difference between doing the basics vs anything else I tried didn't make that much difference, so I'm doing the basics.

 

[LoisLane]

When you look at the overall asset allocation and hold different things in different places, you should ideally correct for the fact that the government owns a share of whatever is in tax deferred.
….
(Snipped)

The bonds belonging to the government hiding in tax deferred can be found by:
% of total savings that is tax deferred
x % bonds in tax deferred
x %marginal tax bracket

I haven’t seen enough discussion about how the government’s share of tax-deferred funds is not actually fixed. That “share” can actually go down to zero or relatively little in years where there are high tax deductions for medical care, like for residential care (which I recently read will eventually apply to 70% of Americans over 65). Even some of the cost of assisted living costs can be deductible when part of the fee is certified by the facility to have been used for medically necessary assistance.

The federal government’s share of a partial conversion from a tax-deferred account to a Roth account can also be zero or low during years of low taxable income.

(As most of my income is dividends but I’ve been paying high health insurance premiums and other tax deductions, I’ve had many years when I was in the 0% tax rate——and could have done partial conversions during those years with 0% federal tax, but the marginal tax rate from the state would have been about 9%.)

I’m personally wondering how much to leave in tax-deferred accounts to cover the cost of health-related expenses. At age 62, I have about $170,000 presently in tax-deferred accounts (with much more in taxable accounts) and should perhaps *not* do any more Roth conversions at all (since I do have to pay state tax on them). In the years to come where I have high medical expenses, I could conceivably purposefully withdraw some funds from my tax-deferred accounts to pay for or offset those expenses, and those expenses would then be free of both federal and state taxes.

So part of the potential drawback of doing Roth conversions is paying federal and/or state taxes unnecessarily on tax-deferred funds, depending on how much is being held in those funds, if we would have been likely to need to put those tax-deferred funds to use for tax-deductible expenses.

For example, say you end up having to pay for $60,000 or $70,000 worth of residential care annually in your late 70’s, and there are additional medical expenses as well. Using RMDs and perhaps additional funds from tax-deferred accounts would be very useful for covering the portion that is deemed to be for medical assistance.

Has anyone seen an analysis of how much we should leave in tax-deferred accounts to pay for health care costs down the road? I read elsewhere that one person was planning to leave $300,000 in his tax-deferred account, but not whether this was based on any research.

 

[FI_RElater]

I haven’t seen enough discussion about how the government’s share of tax-deferred funds is not actually fixed. That “share” can actually go down to zero or relatively little in years where there are high tax deductions for medical care, like for residential care (which I recently read will eventually apply to 70% of Americans over 65). Even some of the cost of assisted living costs can be deductible when part of the fee is certified by the facility to have been used for medically necessary assistance.

The federal government’s share of a partial conversion from a tax-deferred account to a Roth account can also be zero or low during years of low taxable income.

(As most of my income is dividends but I’ve been paying high health insurance premiums and other tax deductions, I’ve had many years when I was in the 0% tax rate——and could have done partial conversions during those years with 0% federal tax, but the marginal tax rate from the state would have been about 9%.)

I’m personally wondering how much to leave in tax-deferred accounts to cover the cost of health-related expenses. At age 62, I have about $170,000 presently in tax-deferred accounts (with much more in taxable accounts) and should perhaps *not* do any more Roth conversions at all (since I do have to pay state tax on them). In the years to come where I have high medical expenses, I could conceivably purposefully withdraw some funds from my tax-deferred accounts to pay for or offset those expenses, and those expenses would then be free of both federal and state taxes.

So part of the potential drawback of doing Roth conversions is paying federal and/or state taxes unnecessarily on tax-deferred funds, depending on how much is being held in those funds, if we would have been likely to need to put those tax-deferred funds to use for tax-deductible expenses.

For example, say you end up having to pay for $60,000 or $70,000 worth of residential care annually in your late 70’s, and there are additional medical expenses as well. Using RMDs and perhaps additional funds from tax-deferred accounts would be very useful for covering the portion that is deemed to be for medical assistance.

Has anyone seen an analysis of how much we should leave in tax-deferred accounts to pay for health care costs down the road? I read elsewhere that one person was planning to leave $300,000 in his tax-deferred account, but not whether this was based on any research.

While I'm not sure that such research would be useful (after all, we can get "population" statistics but that's not really appropriate for an individual) there is info on median lengths of stays in various assisted living, etc.
In general, while the length of stay in nursing home (skilled care) was only about two years... I'd plan on what it would take for five years... determine what your income would still be from SS /pension to get residual number that would be needed

{ex, $140 k pa for care less $24 k SS and $16 k pension results in $100 k pa need... thus half mil for five years }

[hmmm, from your post indicating 9% tax... seems to imply Oregon... hope you are doing well from the fires]

 

[RunningBum]

Has anyone seen an analysis of how much we should leave in tax-deferred accounts to pay for health care costs down the road?

I thought about this, but it seems like any benefit of leaving some money in tax deferred is offset by the number of early years of RMDs where I wouldn't have the expenses to write off. I haven't analyzed the numbers, and of course it's a guess to know what age I might need help. My mother needed memory care at 84, my father is 87 and is still in independent living. The delay of RMDs to age 72 helps a little, but that still is a lot of years of paying tax on RMDs.

An alternate plan to compare is to sell highly appreciated funds to pay the managed care costs. I have plenty where 75% of the proceeds are gains that will be taxed at LTCG rates and can be written off with medical expense deductions. I haven't run those numbers either, but this has the advantage that you can wait and take income if/when you need it, rather than RMDs forcing you to take some extra income.

 

[Dtail]

I haven’t seen enough discussion about how the government’s share of tax-deferred funds is not actually fixed. That “share” can actually go down to zero or relatively little in years where there are high tax deductions for medical care, like for residential care (which I recently read will eventually apply to 70% of Americans over 65). Even some of the cost of assisted living costs can be deductible when part of the fee is certified by the facility to have been used for medically necessary assistance.

The federal government’s share of a partial conversion from a tax-deferred account to a Roth account can also be zero or low during years of low taxable income.

(As most of my income is dividends but I’ve been paying high health insurance premiums and other tax deductions, I’ve had many years when I was in the 0% tax rate——and could have done partial conversions during those years with 0% federal tax, but the marginal tax rate from the state would have been about 9%.)

I’m personally wondering how much to leave in tax-deferred accounts to cover the cost of health-related expenses. At age 62, I have about $170,000 presently in tax-deferred accounts (with much more in taxable accounts) and should perhaps *not* do any more Roth conversions at all (since I do have to pay state tax on them). In the years to come where I have high medical expenses, I could conceivably purposefully withdraw some funds from my tax-deferred accounts to pay for or offset those expenses, and those expenses would then be free of both federal and state taxes.

So part of the potential drawback of doing Roth conversions is paying federal and/or state taxes unnecessarily on tax-deferred funds, depending on how much is being held in those funds, if we would have been likely to need to put those tax-deferred funds to use for tax-deductible expenses.

For example, say you end up having to pay for $60,000 or $70,000 worth of residential care annually in your late 70’s, and there are additional medical expenses as well. Using RMDs and perhaps additional funds from tax-deferred accounts would be very useful for covering the portion that is deemed to be for medical assistance.

Has anyone seen an analysis of how much we should leave in tax-deferred accounts to pay for health care costs down the road? I read elsewhere that one person was planning to leave $300,000 in his tax-deferred account, but not whether this was based on any research.

Was also wondering about this concept.
Using one example, my parents will have about 120k of unreimbursed medical expenses this year, as my father who is 91 y.o. has 24/7 home care.
Between SS/Pensions/Investment income and natural RMD distributions, the sum is already 140k.
Thus I was wondering if they should take more RMD's to maximize lower brackets this year, plus expected future years.
The TIRA balances are 490k.

 

[RunningBum]

Was also wondering about this concept.
Using one example, my parents will have about 120k of unreimbursed medical expenses this year, as my father who is 91 y.o. has 24/7 home care.
Between SS/Pensions/Investment income and natural RMD distributions, the sum is already 140k.
Thus I was wondering if they should take more RMD's to maximize lower brackets this year, plus expected future years.
The TIRA balances are 490k.

Run the numbers in a tax calculator. Don't forget the first 7.5% of income is subtracted from medical expenses. So that's $140K income - $110K medical deduction = $30K income, in my obviously very rough tax calc. Probably worth taking them to the top of 12% or where QDivs start being taxed but you should look at it closer than my 5 minute estimate with limited info.

I think people sometimes see $100K of income and $100K of medical and think they'll have $0 taxable income. Not quite, because of that 7.5%, which btw means as you add income, a little bit less (7.5%) of the medical expenses are deductible.

 

[Dtail]

Run the numbers in a tax calculator. Don't forget the first 7.5% of income is subtracted from medical expenses. So that's $140K income - $110K medical deduction = $30K income, in my obviously very rough tax calc. Probably worth taking them to the top of 12% or where QDivs start being taxed but you should look at it closer than my 5 minute estimate with limited info.

I think people sometimes see $100K of income and $100K of medical and think they'll have $0 taxable income. Not quite, because of that 7.5%, which btw means as you add income, a little bit less (7.5%) of the medical expenses are deductible.

Yeah was kind of thinking that too.
~67% of their market exposure is also in the TIRA's and all their market exposure is in deferred type accounts, so would need to deploy the monies from a taxable account going forward to keep the same exposure.

Then of course there is the unknown "end date", as to depleting the TIRA but still having ongoing unusable deductions.

 

[Out-to-Lunch]

I’m personally wondering how much to leave in tax-deferred accounts to cover the cost of health-related expenses. At age 62, I have about $170,000 presently in tax-deferred accounts (with much more in taxable accounts) and should perhaps *not* do any more Roth conversions at all (since I do have to pay state tax on them).

[snip]

Has anyone seen an analysis of how much we should leave in tax-deferred accounts to pay for health care costs down the road? I read elsewhere that one person was planning to leave $300,000 in his tax-deferred account, but not whether this was based on any research.

Yes, this is a very good question! Of course, a lot depends on other factors, like the size of one's nest egg and where it is located. Most (~70%) of my money is in tax-deferred accounts. I have not done a rigorous analysis, but, after taking a SWAG, we decided to leave ~$500k (out of ~$2M) in tax-deferred for possible medical expenses and charitable giving.

Factors assessed included how big the RMDs would be with that much left in TDA, and also what it would take to Roth-convert the balance. I also freely admit that the number "500" (rather than "300" or "700") might be related to the number of fingers I have on one hand.

But I would like to assess this more carefully. If you come across anything worth considering, please bring it to our attention.

 

[Sunset]

Was also wondering about this concept.
Using one example, my parents will have about 120k of unreimbursed medical expenses this year, as my father who is 91 y.o. has 24/7 home care.
Between SS/Pensions/Investment income and natural RMD distributions, the sum is already 140k.
Thus I was wondering if they should take more RMD's to maximize lower brackets this year, plus expected future years.
The TIRA balances are 490k.

Run it by a tax program, but the answer is YES. How much more is the key.

Rough thinking:
Currently income $140K + (add in 50K for fun)
Deductions: Married = $25K , medical (reduced by 190x.075 = 14.25K) is $105.75K deduction.

So net values is $190K income - $130.75 deductions = $59.25K taxable income the marginal rate is well within 12%

Without the medical deduction they are well into the 22% bracket

So my simple example would save paying at least $5K taxes on that $50K assuming it gets withdrawn in the future.

 

[Sunset]

.......
Has anyone seen an analysis of how much we should leave in tax-deferred accounts to pay for health care costs down the road? I read elsewhere that one person was planning to leave $300,000 in his tax-deferred account, but not whether this was based on any research.

Could have been me, as that's what I believe. It's not based on research, other than having investigated nursing home placements for a relative, and the cost per year.

The nursing homes I found charged in the range of $100K/yr for "acceptable" ones, and this is very dependent upon location.

These nursing homes, would only accept a person if they had 3 yrs worth of money to pay before switching to medicaid, so the $300K number conveniently is close.

 

[Dtail]

Run it by a tax program, but the answer is YES. How much more is the key.

Rough thinking:
Currently income $140K + (add in 50K for fun)
Deductions: Married = $25K , medical (reduced by 190x.075 = 14.25K) is $105.75K deduction.

So net values is $190K income - $130.75 deductions = $59.25K taxable income the marginal rate is well within 12%

Without the medical deduction they are well into the 22% bracket

So my simple example would save paying at least $5K taxes on that $50K assuming it gets withdrawn in the future.

Aren't you double counting the married deduction, since they would already be using the itemized deduction vs. the standard deduction?

 

[youbet]

Could have been me, as that's what I believe. It's not based on research, other than having investigated nursing home placements for a relative, and the cost per year.

The nursing homes I found charged in the range of $100K/yr for "acceptable" ones, and this is very dependent upon location.

These nursing homes, would only accept a person if they had 3 yrs worth of money to pay before switching to medicaid, so the $300K number conveniently is close.

$300k is probably as good a guess as any, but I look at it another way.

I want to have enough set aside for our NH self-insurance that it's unlikely that having either of us be in one for years would leave the other impoverished. (I consider spending down to Medicaid leaving the healthy spouse impoverished.) So, while I can continue to make the plan work, we have roughly one million bux set aside.

Without the spousal dependency, the $300k number sounds fine. Of my one million (for a couple) suggestion, having $600k in tax deferred sounds good tax-wise.

It's all a crap shoot. It's end of life planning..........

 

[Sunset]

Aren't you double counting the married deduction, since they would already be using the itemized deduction vs. the standard deduction?

You are Right Good of you to point that out.

That would change the numbers, putting them nearer the top of the 12%.

They would have a property tax deduction, but it would only be a small amount.

Which is why running it through a tax program, even last year's program would give a better estimate.

 

[Dtail]

You are Right Good of you to point that out.

That would change the numbers, putting them nearer the top of the 12%.

They would have a property tax deduction, but it would only be a small amount.

Which is why running it through a tax program, even last year's program would give a better estimate.

Yeah just ran it through a basic tax calculator and there wouldn't be much room over the 50k you used for the top of the 12% bracket.
Their natural RMD is ~42k already.

 

[LoisLane]

Was also wondering about this concept.
Using one example, my parents will have about 120k of unreimbursed medical expenses this year, as my father who is 91 y.o. has 24/7 home care.
Between SS/Pensions/Investment income and natural RMD distributions, the sum is already 140k.
Thus I was wondering if they should take more RMD's to maximize lower brackets this year, plus expected future years.
The TIRA balances are 490k.

Keep in mind the need to avoid increasing the overall income so much income that both parents are hit with that surcharge for Medicare premiums. I think that’s been about 2 x $88,000, or $176,000. So although I haven’t run the numbers through a tax software program, I think you would not want to take more than another $35,000 from the tIRA, keeping the overall income at about $175,000 just to be sure you don’t exceed $176,000. You should first doublecheck whether there might be any unexpected income at the end of the year, like substantial dividends or capital gains, and perhaps see how late in the year you can make the last withdrawal from the tIRA.

 

[Dtail]

Keep in mind the need to avoid increasing the overall income so much income that both parents are hit with that surcharge for Medicare premiums. I think that’s been about 2 x $88,000, or $176,000. So although I haven’t run the numbers through a tax software program, I think you would not want to take more than another $35,000 from the tIRA, keeping the overall income at about $175,000 just to be sure you don’t exceed $176,000. You should first doublecheck whether there might be any unexpected income at the end of the year, like substantial dividends or capital gains, and perhaps see how late in the year you can make the last withdrawal from the tIRA.

Good thought on the IRMAA and it is 176k, although based on one's income from 2 years prior.
There aren't any unexpected capital gains/dividends, as all their stock exposure is in deferred accounts.
I do have their RMD's taken out in Dec, not to mention the tax withholding for the year.